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Abstract

A liquidity trap is no longer a mere theoretical curiosity after Japan’s economic slump in the early 1990s and the recent global recession triggered by economic depression in the United States in 2007. Several non-standard policy alternatives have been prescribed to combat a liquidity trap. One of them is the conditional policy commitment that keeps nominal interest rate near zero depending on the state of the economy. Such a credible commitment is expected to stimulate the economy by raising asset prices. Using the principle of adaptive learning, this article analyzes the impact of a conditional policy commitment on a liquidity trap, which keeps nominal interest rate near zero when the inflation rate is below a unique threshold level. I would show that a conditional policy commitment like this eliminates a liquidity trap and the associated deflationary spiral by anchoring inflationary expectations. As a result, the targeted equilibrium becomes globally stable.

JEL Classification: E63, E52, E58

Keywords

Adaptive learning monetary policy fiscal policy zero interest rate lower bound

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Liquidity Trap and the Conditional Policy Commitment: An Analysis under Adaptive Learning

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